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One of the first steps you must take when starting a new business is to decide on the business structure you will use. How do you make that choice? Following is a brief overview of how the most common business structures vary based on liability, taxes, and administration.
Sole Proprietor
The sole proprietor business structure is one that can be used by an individual or married couple in business alone. This structure is often the least complicated to administer and taxes, which are reported on the IRS 1040 form’s Schedule C, are handled in a fairly straightforward manner. But this business structure provides no liability protection for the business owner.
“It’s just you,” said attorney John San Fellipo. “In a sole proprietorship you are personally liable for all business debts.”
This means that if your company is sued, the person filing the lawsuit can go after your personal as well as your business possessions, including your car, house, and personal bank accounts.
General Partnership
A general partnership is a simple partnership structure made up of two or more people who wish to do business together. In the past, professionals, such as doctors and attorneys, were not able to form corporations, and so this structure was frequently used instead. Administration of a general partnership is not complicated and although taxes are more complex from a paperwork perspective, the tax burden for each partner usually ends up being the same as that of a sole proprietor.
From a liability standpoint, a general partnership “exposes you to liability you cannot control,” said San Fellipo. All partners in a general partnership are liable for business expenses and debts. So if one partner opens the company up to liability, all partners’ assets can be targeted.
Limited Partnership
In a limited partnership structure there are one or more general partners and one or more limited partners. The general partners in this structure are responsible for the day-to-day operation of the business and have the same liability exposure as a general partnership. The limited partners in this structure do have protection that limits their liability to the money they’ve invested in the company.
To keep this liability protection, however, limited partners’ involvement in the business is restricted. They can usually only have a financial investment in the company. If they become too involved in running the business they run the risk of assuming greater liability.
Corporation
Corporations are made up of three distinct groups of people: stockholders, a board of directors, and officers. It is possible to have a corporation of one. In this instance the three groups of people would all be the same person. Corporations have a much more complicated structure from an administration standpoint than most other business structures and have a number of formal operating requirements
From a tax perspective there are two kinds of corporations, C corporations and S corporations. C corps are often used as structures for large, public companies, such as Boeing and Microsoft. C corps have two levels of taxation: the corporation gets taxed on its net income and the dividends distributed to the shareholders are also taxed.
“In the time I’ve been practicing I think I’ve done five C corps,” said Ed Wolfe, attorney, of Wolfe Law Offices, PLLC, in Bremerton. “The companies I represent are rarely large enough to need this structure.”
The S corp tax structure is usually a better choice for small to medium-sized businesses. It does not have the double taxation considerations that a C corp has. Rather it is a “flow-through” entity, where all income is taxed directly to the shareholders – which, in this structure, are normally the corporation owners.
Corporations provide significant liability protection for the corporation owners but care must be taken to keep your business and personal lives completely separate.
“Small businesses tend to get in trouble by blurring the line between business and personal dealings,” said San Fellipo. Actions such as using corporate accounts to pay for personal expenses can open corporation owners up to personal liability.
“People who sue corporations will attempt to ‘pierce the corporate veil,’” said attorney John Kenney, of Lineberry Kenney’s Poulsbo office, a term used to describe corporation owners mixing business and personal finances. “If they can prove that, the court will not respect the corporation because you haven’t respected it.”
Limited Liability Partnership
A limited liability partnership is something of a hybrid between a corporation and a general partnership. In a limited liability partnership, all partners can actively engage in running the business, and all are offered liability protection. Operating a limited liability partnership is similar to running a general partnership, and taxation is also similar.
Limited Liability Company
The limited liability company is a structure that has been available to businesses for about 25 years. In Washington a limited liability company can consist of one person. This business structure provides liability protection for all owners, as a corporation does, but is fairly easy to administer and maintain, with fewer formal requirements than a corporation.
Single-owner LLCs are taxed the same way a sole proprietorship would be. LLCs owned by more than one person can be taxed as either a partnership, which is the default taxation method, or as a corporation.
Unfortunately there isn’t a simple formula that you can apply to determine which structure is the best one for you.
“There is no rule of thumb,” said Kenney.
For this reason, consulting with a business attorney and/or tax professional to make sure that you have all the facts and information you need is a good idea. Wolfe advises his clients to start with a good business plan before even beginning to consider which business structure is the best one for them. Then, once they have a business plan in place, “I ask what do you want to do, how big do you want to be,” said Wolfe. “Then I say, ‘if you don’t have a CPA, you should have one.’”
(Editor’s Note: This article is designed for informational purposes only and is not intended as legal advice. You should seek the advice of your own attorney or corporate counsel if you have specific questions about the issues addressed here.). | 
